Thursday, February 26, 2009

For once a positive headline about the venture capital market -- Venture Capital Investing Up 5%. However, like much good news, the trick is to read the dek -- the increase in investments was OUTSIDE the United States and focused on emerging markets like India, the PRC and Israel.

On the one hand, this could be disconcerting news to US entrepreneurs. If the money is going out of the country, then it is not here to fund your project. On the other hand, in a practical sense this is good news for entrepreneurs. The VCs are still investing in projects. The trick is to provide the VC with the sorts of returns he is expecting. I give a lot more detail on these expectations here.

Right now, the home run returns can be visualized in India and China. (Although very few have materialized to date.) And the investments are often being made in sectors that sound foreign to the VC world of the last 9 years. For example, investments are being made in education, hardware manufacturing and infrastructure. (Rather than web 2.0, Saas, cleantech and the cloud). However, when you take into account the massive and growing middle class in India and China, these investments have the potential for the kind of explosive growth that a VC is looking for. When you think about it, many of the technology fields that powered the VC boom in the last two decades are now relatively mature industries. The PC, the internet, cell phone technology, Web 1.0, even Web 2.0 in many ways. Thus, the trend of many VCs in the US moving away from traditional computer and information technology and into cleantech, biotech and medical devices.

In my mind, the takeaway from this for a budding entrepreneur should be, "how can I innovate in a manner that has the potential to generate explosive returns?" If you can do this, there is plenty of money to be had.
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Wednesday, February 25, 2009

Do you need a crash course in how to find venture capital funding for your company? Or perhaps just a refresher course? The deck below was prepared by Jason Mendelson, a VC with the Foundry Group and Mobius Venture Capital. It provides a good succinct primer on venture capital and echoes many of the themes on this blog. Enjoy!

Monday, February 23, 2009

Just when the Boxee party started getting really good, Hulu had to come along and p*ss in the punchbowl. Apparently, Hulu is bowing to pressure from "content providers" and is blocking access to Hulu from Boxee.

I have written before several times about Boxee -- the revolutionary software that allows you to view internet based TV/movies seamlessly on your TV.

One of the features that makes it most useful, at least for me, is that Boxee allows you to stream the television content contained on sites such as Hulu or ABC.com directly to your TV. This solves the "last mile" connectivity issue between my iMac (which has access to virtually anything via the internet) and my HDTV which has a big screen and great clarity but no access to anything on the internet.

Hulu provides internet access to, among others, the main Fox and NBC television shows. When you watch the show, Hulu inserts some commercials in show breaks. These commercials cannot be fast-forwarded through or skipped. The result is the same whether you are watching Hulu on your personal computer or whether you are watching Hulu on your TV set via Boxee. Either way you see the commercials. Consequently, it should not matter to the true content provider on what device the content is viewed. Either way the content provider receives its advertising revenue.

To me, this seems like a much better outcome than the alternative where the end user pirates the content from one of the myriad torrent sites and watches it for free and without seeing any commercials. Unfortunately, by blocking Hulu from Boxee, the "content providers" seem to be traversing the same path that the record companies cut in the late 90s. Rather than recognizing innovation and attempting to monetize it as it happens they are attempting to squash innovation in a vain attempt to control the medium. This may well prove to be folly.
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Sunday, February 22, 2009

It looks like Twitter's run of good luck and good times will continue. To update my earlier post post on the subject, Twitter's actual venture capital raise was in excess of $35 million dollars. Twitter raised $35 million from new investors and, according to TechCrunch, several of Twitter's earlier round investors also bought their pro rata shares.

Twitter still has virtually no revenues and no real plan at this point on how to generate any. But hey, they have a huge and growing user-base and now they have a lot more money to spend on figuring out how to generate revenues.

In a recent blog post, Mark Cuban committed to funding any entrepreneur with a proposal that met certain criteria. He called this commitment his own personal "stimulus plan" and stated that entrepreneurs can "lead us out of this mess."

To quote Cuban:

As I find businesses I like, I will use the email address you provide before you post to get in contact with you. There will be a standard agreement, you can take it or leave it. Once I have done the standard agreement, I will post it here for all to see. This will definitely be a work in progress. Maybe it leads to great things, maybe it leads to nothing. We will find out. I'm not going to claim a minimum or maximum amount or total I will invest. I'm not promising I will definitely invest anything. If nothing comes along that I think is viable, that's the way it goes. Hopefully I will invest in quite a few businesses that will lead to something more.

Here are the criteria:

1. It can be an existing business or a start up.2. It can not be a business that generates any revenue from advertising. Why? Because I want this to be a business where you sell something and get paid for it. That's the only way to get and stay profitable in such a short period of time.3. It MUST BE CASH FLOW BREAK EVEN within 60 days4. It must be profitable within 90 days.5. Funding will be on a monthly basis. If you don't make your numbers, the funding stops.6. You must demonstrate as part of your plan that you sell your product or service for more than what it costs you to produce, fully encumbered.7. Everyone must work. The organization is completely flat. There are no employees reporting to managers. There is the founder/owners and everyone else.8. You must post your business plan here, or you can post it on slideshare.com, scribd.com or google docs, all completely public for anyone to see and/or download.9. I make no promises that if your business is profitable, that I will invest more money. Once you get the initial funding you are on your own.10. I will make no promises that I will be available to offer help. If I want to, I will. If not, I wont.11. If you do get money, it goes into a bank that I specify, and I have the ability to watch the funds flow and the opportunity to require that I cosign any outflows.12. In your business plan, make sure to specify how much equity I will receive or how I will get a return on my money.13. No multi-level marketing programs. (added 2/10/09 1pm)

If you are interested in getting some of Cuban's "open source funding" click on his blog link and apply by leaving a comment. More than 1300 people have already done just that.
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Monday, February 16, 2009

Should a start-up consider classifying its workers as consultants rather than employees? Generally this is a bad idea. However, it is common for a start-up to classify its founders or other employees as consultants in order to avoid withholding taxes from their (typically limited) pay checks. More below the fold.

The IRS does not really pay attention to your justifications for classifying a particular person as a consultant and filing 1099s. Instead, they are going to look at how much control the company has over the person you claim is a consultant. Too much control = not a consultant. This matters because, if the IRS determines that someone you have been treating as a consultant is actually an employee, then the company will have liability for taxes that were not withheld as well as potential liability for interest and penalties.

This is precisely the sort of issue that will give a venture capitalist an excuse not to invest in your business. These sorts of issues are pretty obvious during the diligence process and the VC will require that all of this is cleaned up before they entrust you with any of their LP's money.

A natural question would be -- what about my actual consultants? How can I tell and ensure that they will get the correct "consultant" treatment. To answer this, I have always used a 20 question test that distills the IRS rulings in this area, I have included in parenthesis the answer you want to hear if you want to classify this person as a consultant.

1. Is the consultant required to comply with your instructions as to when, where, and how the work is to be done? (No.)

2. Did you provide the consultant with training to enable him to perform his job in a particular method or manner? (No.)

3. Are the services the consultant provides integrated into your business operation? (No.)

4. Must the services be rendered by the consultant personally? (No.)

5. Does the consultant have the capability to hire, supervise, or pay assistants to help him in performing the services under contract? (Yes.)

6. Is the relationship between the consultant and your company a continuing relationship? (No.)

7. Who sets the hours of work? (The consultant does.)

8. Is the consultant required to devote his full time to the your company? (No.)

9. Does the consultant perform the work at your company's place of business? (No.)

10. Who directs the order or sequence in which the consultant works? (The consultant does.)

11. Is the consultant required to provide regular written or oral reports to you? (No.)

12. What is the method of payment - hourly, commission or by the job? (Fixed price, not-to-exceed, and/or milestone payments are generally standard for independent contractors.)

13. Do you reimburse the consultant for his business and/or traveling expenses? (No.)

14. Who furnishes tools and materials used by the consultant in providing services? (The consultant does. This includes workstation, internet access, etc.)

15. Does the consultant have a significant investment in the facilities he uses to perform his services? (Yes. The focus here is on the word "significant." Lots of employees have a home computer.)

16. Can the consultant realize both a profit and a loss from his work? (Yes-the consultant must assume risk based on whether you are satisfied with his work.)

17. Can the consultant work for a number of firms at the same time? (Yes.)

18. Does the consultant make his services available to the general public? (Yes. For example, the consultant should have business cards, stationery, invoices, and a business listing in the phone book.)

19. Is the consultant subject to dismissal for reasons other than nonperformance of contract specifications? (No.)

20. Can the consultant terminate the relationship without incurring a liability for failure to complete a job? (No. If the consultant works on a project or milestone basis, the consultant must deliver to receive payment for his efforts.)

You should note that no one of these factors is determinative. However, if you answered one or more of them incorrectly you should consider discussing the potential consulting engagement with your counsel. Also, when considering these factors, please note that your mileage may vary depending upon your situation and the state(s) in which you do business. Please consult an experienced employment lawyer if you are pondering a close call.Click Here to Read More..

Sunday, February 15, 2009

What are the seven critical business factors you should consider when you want to obtain venture capital funding? I came across the list below the other day and appreciated the no-frills business perspective. It was prepared by Garage Technology Ventures, a seed-stage and early-stage venture capital fund.

Saturday, February 14, 2009

Will cleantech and biotech be the growth industries for small business start-ups in 2009? Cliff Schorer believes so and discusses his thoughts in the video below from Big Think.

What is perhaps counter-intuitive about his analysis is that the cleantech and biotech start-up sectors are the most capital intensive of the various start-up sectors. This would seem to make it harder to get going for an entrepreneur. (Although see this blog post by Mark Reiboldt on how to bootstrap a biotech or cleantech startup).

On the other hand, as I noted previously, these are precisely the sectors that have the best chance for stimulus funding, have seen the largest number of new venture capital investments and that play into the very large fund sizes that VCs have raised in the last two years. So, although picking these capital intensive sectors may seem like an "oxymoron" (to use Cliff Shorer's phrase) on the other hand it makes a lot of sense.

Wednesday, February 11, 2009

Raising venture capital is never an easy task. The target seems to always be in motion and you are subject to macro trends which are completely beyond your control.

With this in mind, below is a quick list of five things an entrepreneur should keep in mind:

1. No VC has ever invested in the perfect business plan. While the creation of your business plan is an important thought process for refining your ideas and anticipating challenges, it is nowhere near as important as actually implementing your business and/or proving your concept. You need to have a business plan to show that you understand what you are doing and what the challenges and risks will be, but without evidence of action, a business plan is not worth the glossy paper it is printed upon. Note -- angels WILL invest in just an idea/business plan, see point 2 below.

3. Can you explain your business to a 5th grader? Most 10 year olds are savvy enough to understand the fundamentals of virtually every business. If you can't explain your business to a 5th grader, you should spend more time thinking about what the core of your business is. It always amazes me when a (potential) entrepreneur cannot explain his business to me in a way that fundamentally makes sense -- and, according to my wife, I am slightly more sophisticated than a 5th grader.

4. Don't BS people. Anyone that is a real source of funding is sophisticated enough to see through a sales routine. They may not call you out on your "marketing" but they certainly won't invest. Answer questions directly and when you don't know the answer, admit it. Don't tell the investor or his advisors what you think they want to hear. Trust me, it is more obvious than you think. Also, don't over play the buzz words. If they are buzz words, the novelty has already worn off. Seriously, Web 2.0/3.0 just does not get people excited anymore. Explain what you are doing and how you are going to do it -- see point 3 above.

5. Investors go with who they know. As an entrepreneur, if you don't already know potential investors, then you need to start getting to know them. Talk to your local incubator, present to some angels, meet professional advisors in your sector. You could even try commenting on relevant blogs. A pitch given via a warm introduction has a vastly superior chance of succeeding when compared to a cold call or a true elevator pitch.

Tuesday, February 10, 2009

A list of the most common mistakes "geeks" make when starting businesses that hope to raise venture capital. This top 10 list was prepared by Ron Garrett way back in 2006, but it has some excellent advice for today's modern age and I have re-read it and forwarded it several times over the years. I don't agree with all of it, but it is a very useful conversation starter.

Monday, February 9, 2009

I have written before several times about Boxee -- the revolutionary software that allows you to view internet based TV/movies seamlessly on your TV.

Personally, I have my iMac connected directly into my HDTV (using a Mini DVI to HDMI converter). However, a few of you have asked me what to do if you cannot connect your computer directly to your TV.

One very promising option is to use the AppleTV. This is a $230 hard drive that connects directly to your TV. You just need to get it hooked into the internet. Boxee has a configuration that is designed for the AppleTV and apparently it works great.

Yesterday, the New York Post featured the Boxee/AppleTV set up in an article it titled "The Future of Television." It is an interesting read, both for the mechanics of the set-up but also for the discussion of where TV is going and how Boxee is changing the game.

Found this book review over the weekend. It looks like the Matrix (or the Terminator depending upon your age) is a lot closer to reality than I thought. The review itself is a crazy enough read that I am going to pick up the book. I'll post if it is as interesting as I hope.

A few key quotes:

The irony is that the military will want it [a robot] to be able learn, react, etc., in order for it to do its mission well. But they won’t want it to be too creative, just like with soldiers. But once you reach a space where it is really capable, how do you limit them? To be honest, I don’t think we can.

The reality is that the human location “in the loop” is already becoming, as retired Army colonel Thomas Adams notes, that of “a supervisor who serves in a fail-safe capacity in the event of a system malfunction.” Even then, he thinks the speed, confusion, and information overload of modern-day war will soon move the whole process outside of “human space.” He describes how the coming weapons “will be too fast, too small, too numerous, and will create an environment too complex for humans to direct.” As Adams concludes, the various new technologies “are rapidly taking us to a place where we may not want to go, but probably are unable to avoid.”

So, despite what one article called “all the lip service paid to keeping a human in the loop,” the cold, hard, metallic reality is that autonomous armed robots are coming to war. They simply make too much sense to the people that matter. A Special Operations Forces officer put it this way:

“That’s exactly the kind of thing that scares the shit out of me. . . . But we are on the pathway already. It’s inevitable.”

Sunday, February 8, 2009

What do venture capital analysts do? And why do venture capitalists need them?

The link below is to a blog post from Scott Scheper that answers these questions. First, it sheds some light on the "glamorous" job that the analysts do within a VC firm.

Second, and perhaps most importantly, it illuminates the crucial difference between an angel investor and a venture capital fund. Angel investors typically do not have the infrastructure or desire to perform a proper valuation and financial analysis of the entrepreneur's company. They typically are investing by their gut or with their friend/family/neighbor. If you can sell them on your idea and on you, then you are most of the way there. Venture capitalists, on the other hand, report to a higher power -- their LPs. They usually will have a fiduciary duty to act with care in their management of the funds assets. More importantly, they need to keep their LPs happy so that the LPs will re-up in the next round of fundraising. When a particular deal turns out to have been a bad one, the VC will want to be able to demonstrate what they were thinking at the time they made the investment. This is why they need to do the fulsome valuation analysis.

A third "sub" point -- the article also alludes to the tension between what types of investments an early stage VC fund is interested in and what types of investments an angel may consider. If it can't be shown through a full valuation that the idea has the potential to hit the VC's desired returns, then the investment will not be made. A very exciting idea may not receive interest from a VC because it is either too speculative or because it is not obvious that the desired returns will be there. These sorts of ideas will be dependent on angel funding until they have proven their concept -- or perhaps exclusively until they have the balance sheet for debt or can find an exit through M&A or IPO. For more on the types of returns that different investors seek at different phases of a company's lifestyle, here is a recent blog post of mine.

Friday, February 6, 2009

A second clip from bigthink featuring Michael Lewis of Liar's Poker fame (among other things). The first one is here.

In this clip he focuses on the financial markets and the mistakes that led us to this downturn. It is a longer piece, but has some real gems throughout.

A few notable quotes:

1) The SEC is very good at hounding people who have done trivial things.2) We actually were deluded into thinking that nothing could really go wrong.3) The money that was being invested had no capacity to understand what it was being invested in.4) There is a natural limit to the amount of complexity the markets can assimilate.

Rather than investing in new concepts and start-ups, growth stage venture capitalists focus on companies that are already profitable and relatively mature. These companies may be looking to enter a new market, to finance a bolt on acquisition, or to expand operations.

A recent Forbes article noted that in the current economic environment, venture money is gravitating away from the high risk/high return early stage investments to the more moderate risk/moderate return growth stage investments. This move towards growth stage investing may also be a result of the relatively large venture funds that have been raised in recent years. Growth stage investing requires larger investments (from $5 million to $100 million or more) and is more suited to the multi-billion dollar funds found in recent vintages. In an early blog post, I noted that these larger funds would also gravitate towards the capital intensive VC sectors that are popular now -- such as cleantech and biotech.

You may wonder why these companies that are generating revenue and have operating profits would turn to an equity investor rather than simply borrow the money they need, since debt is usually cheaper than equity. Typically, it is because debt is unavailable for one reason or another. Perhaps the company already has too much (or just enough) debt on its balance sheet or it has unstable or lumpy earnings that are difficult to borrow against. Or perhaps the new opportunity that the company sees is just too expensive for the company to finance entirely with debt.

Growth capital really exists at a cross-roads in the private equity world. On the one hand, it is frequently financed by venture capital funds that will approach it as a minority investment and will negotiate accordingly. On the other hand, larger private equity and buy-out funds will consider taking majority stakes or even minority stakes that have contingencies that can lead to buying the company as a whole -- e.g. buy/sell arrangements, put rights, drag along agreements and rights of first offer/first refusal.

Thursday, February 5, 2009

When an entrepreneur hopes to raise venture financing, a very common mistake he can make is to form the wrong type of entity or to form it in the wrong state. Choosing what type of entity you should form -- that is, choosing between a basic "C" corporation, a limited liability company, a limited partnership, an "S" corporation or a general partnership -- can be a very complex choice and I am not going to go into all of the legal and tax ramifications here. However, venture capitalists have very distinct and particular opinions on this decision. By making the wrong choice you will hamper your ability to raise venture capital and/or create costs and complexity down the road when your prospective VC request you "do things over." More after the break.

Potential venture capital investors have clear preferences and expectations as to how their transactions will be structured. Generally, in order to get a venture capital investment, you will need to be organized as a "C" corporation and it is preferable that you be incorporated in Delaware.

VCs will almost never invest in limited liability corporations and will rarely invest in corporations formed in states other than Delaware. VCs will virtually never invest in a partnership and are forbidden from investing in an "S" corporation. In many ways, by forming the wrong type of entity in the wrong state, you will demonstrate your inexperience with and ignorance of the venture capital process. This is the last thing you want to do when you are trying to show off your entrepreneurial savvy to a potential investor.

This is not to say that there are not advantages to be had with different entity types. However, the venture capital process is form driven and the corporate form is tried and tested. Folks just know it works. Every VC has its own set of forms that it basically uses for all investments on which it is lead. The VCs and their attorneys know the forms inside and out and are comfortable quickly making adjustments and changing deal points that will flow across multiple forms and multiple sections within a form. Further, the rights, preferences and privileges of preferred stock are fairly standard and will not vary too much in a particular region and time period. Also, corporations are easily able to issue tax favorable stock options to incentivize their employees. Finally, VCs are comfortable with how to realize liquidity in a corporation -- through IPOs, liquidation events and dividends -- and they understand the various tax treatments.

To make a VC investment in an LLC would require an entirely new set of forms developed from scratch. The classic rights, preferences and privileges of a VC preferred stock investment do not translate easily or comfortably into the LLC format (although, admittedly it can be done). Developing these scratch documents is a costly endeavor (and obtaining venture capital is not cheap anyway) -- it is unlikely at best that a VC will want to bear these additional costs. In addition, an LLC is not able to issue stock options to its employees with the same tax advantages as a corporation. Also, the manners of obtaining liquidity in an LLC (through distributions or liquidation) do not translate easily into the VC world and have potentially different tax treatment. For example, the flow-through tax treatment of an LLC could potentially cause problems for the limited partners of the VC. Finally, and perhaps most importantly, it is not possible to do an IPO with an LLC. Any LLC that wanted to go public would be required to first convert to a corporation anyway with potentially very adverse tax consequences.

This is not to say that an LLC is not an excellent choice for joint ventures or small businesses which will never need to raise money from a VC. LLCs are very flexible entities that can provide favorable tax treatment for individual investors. It is just exceptionally rare to find a VC that is willing to invest in an LLC.

The choice of state question is not as clear cut. However, most venture capitalists have a clear preference to invest in a Delaware corporation. This is because Delaware is still the most common state of incorporation and, consequently, the statute is well thought out and practical and the courts in Delaware are very experienced with corporate law. Delaware law is also very flexible in providing indemnification for officers and directors and for protecting officers and directors from claims of a breach of their fiduciary duties. Nevada law is not a viable alternative, despite the claims of internet incorporation firms to the contrary. It may have similar laws, but it does not have the same experienced judges. On the other hand, it is common for a local venture capitalist to be willing to invest in a corporation formed under the laws of its home state (Virginia for a Virginia VC, California for a California VC), but why limit yourself to local VCs by choosing the local jurisdiction?

In sum, if you are considering starting a business that plans to seek venture capital at some point, you should strongly consider starting out as a Delaware corporation. It happens too often that an entity is ready to start or receive fundraising but first has to re-do its charter documents at great expense and with adverse tax consequences. Venture capitalists simply do not like investing in LLCs.Click Here to Read More..

Outsourcing, although once controversial, is now firmly ensconced in our global economy. However, it is one thing to hire someone in India to do a job, it is quite another to ask (tell) your employee that he has to move to India to keep his job (and take Indian wages). Apparently, this is what IBM is doing.

Wednesday, February 4, 2009

In some emerging growth sectors, such as biotech and cleantech, the most promising source of financing is often not selling equity to a financial investor but instead is from either strategic partnerships with major players in the industry or from government grants and contracts. Or, as we like to call it now, stimulus.

Recently, I have been writing a lot about raising venture capital and angel financing and the different sorts of financing techniques available to an emerging growth company. However, the angel financing/venture capital model does not always work in all emerging growth sectors. For example, in the biotech and cleantech industries, venture capital funds and angel investors may not be the primary source of capital for a successful start-up. More after the break.

These industries are characterized by massive capital requirements and very long runways. That is, they cost a lot and it takes a long time for anyone to make any money. A classic example is an experimental new drug -- the FDA approval process will often take 7 to 10 years or more and the costs of clinical trials in the various phases can run through a hundred million dollars. For a biotech start-up with no revenues, these are daunting hurdles. Similarly, many of the clean-tech concepts require huge capital investments in factory and plant.

It can be very difficult for an early stage company to raise this sort of money from venture capitalists and angel investors. This is why many entrepreneurs in the biotech and clean-tech fields will instead pursue strategic investors. For example, a biotech start-up can form a strategic alliance with one of Big Pharma that will pay for its clinical trials and FDA submissions. Similarly, a clean-tech start-up may be able to partner with an established utility, automobile or energy company to build its plant.

In addition to financing, these strategic investors may also be interested in providing manufacturing services, in supplying raw materials or in distributing the finished goods, energy or drugs. Because of these other "strategic" goals, a strategic investor will typically be a bit less focused on the absolute financial return that can be obtained from the investment. That is, they may be willing to take an instrument with a lower return on its face because they see other value in the strategic relationship.

Another important avenue of opportunity for biotech and clean-tech start-ups is the government. The government is paying particular attention to the health and energy sectors and the opportunities for stimulus packages, grants or contracts are many. Moreover, the House of Representatives recently passed its stimulus bill which included $72 billion for clean energy programs, and another $20 billion for clean energy tax incentives. Initial indications are that the Senate bill will at the very least maintain these levels of cleantech support.

Just because the numbers are down year to year or quarter to quarter, does not mean anything without reference to historical trends. In venture capital, 2007 was a peak year. It should not surprise anyone that 2008 was not on par. However, 2008 was still a good year for venture capital numbers in comparison to 2004 or 2005.

“Long Tail” author Chris Anderson yesterday wrote a WSJ piece called The Economics of Giving It Away, arguing that most online businesses can no longer succeed if CPM-based ads are their only revenue stream. I agree, which is why peHUB offer Premium Subscriptions and hosts events like the Shindigs. But I do take issue with one line in Anderson’s piece, in which he says:“For the first time since 2001, the overall tide of investment and advertising won’t rise. Indeed, it will almost certainly fall. Venture capital has dried up…”It’s undeniably true that venture capital activity has slowed down, but to say it has “dried up” is a massive overstatement. In fact, it’s closer to a canard.

Venture capitalists funded 833 U.S.-based companies in Q4 2008, for a total of $5.47 billion. That’s well off the $8.08 billion invested in Q4 2007, but it’s hardly “dried up.” In fact, it’s pretty close to where the VC market was at the end of 2005, when just $5.79 billion was invested in 810 companies. Moreover, not a single quarter in 2004 even broke the $5 billion mark.

I understand Anderson’s consternation, and it’s true that today’s entrepreneurs need to show clearer revenue paths than they did 15 months ago. But that’s more a reflection of past VC froth than an ability of quality companies to get funded. But there is still plenty of money available, and there will be going forward. Certain things truly have dried up (VC-backed IPOs, mega-LBOs, etc.), but venture capital isn’t one of them.

Tuesday, February 3, 2009

This slideshow does a great job explaining the differences between Web 1.0, 2.0 and 3.0 in a simple straightforward manner. For the more advanced among you, the Part II link at the bottom is to the second "expert" portion of the presentation.

Recently, I have seen a number of articles and blogs discussing a curious feature of recessions. That is, when large numbers of people lose their corporate jobs and are forced out of their comfort zones, some of them will (perhaps out of necessity) innovate. This sort of innovation is what drives entrepreneurship and venture backed companies.

For example, a recent New York Times article on the demise of Venture Capital (a subject I have discussed recently here, here and here) concluded:

If there is a silver lining, the large-scale downsizing from major companies will release a lot of new entrepreneurial talent and ideas — scientists, engineers, business folks now looking to do other things ... There will be a lot of forced entrepreneurship that will lead to innovations.

America may be at the dawn of a new era. No, not the Obama era, but a new era of venture capitalism and entrepreneurship. It may not come immediately, but it will come eventually, much like the earlier great eras of innovation, which sprang forth from the wreckage of an economic crisis.

That's the hopeful view of our current crisis. During the Great Depression the groundwork was laid for some of the mid-20th century's great innovations. RCA's David Sarnoff oversaw the creation of television. IBM Corp., academic and military researchers built early computers. Jet engines were going from proof of concept to a reality in the U.K. and Germany. The list could go on. And after World War II, these technologies dramatically transformed the world and led to economic prosperity.

Similarly, the great stagflation of the 1970s saw a boom in innovations. Apple popularized personal computers. Intel introduced the microprocessor. Microsoft Corp., Lotus and other software companies were founded to capitalize on these new technologies. Motorola Inc. began developing cellular phones. Meanwhile, cable TV networks were being laid by entrepreneurs, and throngs of new TV channels like CNN, HBO and MTV were created to fill the new frontier. Venture capitalists helped academics launch biotechnology startups, and from those efforts came Genentech Inc., Biogen and a host of others. And just as in the period that followed World War II, the world seemed to be transformed through innovation.

Now, I am not making light of the very serious ramifications that losing a job has on many households. However, in a macro sense, I see the silver lining. I have a deep faith in the virtuous cycle of capitalism and entrepreneurship and believe strongly that however great the destruction is in this down-stroke, the resulting up-stroke of creativity will be even greater.
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Monday, February 2, 2009

A few weeks ago, I blogged about whether the SEC's new rules making Form D filings publicly available will actually (and counter-intuitively) made it easier for a company to stay in stealth mode.

In response to that post, I was asked whether, if there is some piece of information that you would be required to disclose in the new Form D that is just too sensitive -- for example, if your lead founder is a name personality in your field and their mere involvement with the project will set off bells in the blogosphere -- can you just skip the Form D filing entirely and find some other exemption from the registration requirements of securities laws. The answer to this question is tricky because failure to file this form is more than a mere administrative defect and such failure can have real consequences. I will explore this in more detail below the break.

As I mentioned previously, all offerings and sales of securities must be either registered with the SEC (i.e a public offering) or exempt from registration with the SEC. The easiest way to ensure that your private offering is exempt from registration is to comply with the SEC’s safe harbor under Reg. D. Unfortunately for stealth mode companies, a central component of the Reg. D safe harbor is the requirement that a company file with the SEC a Form D. Beginning March 16, 2009, all Form D filings will be publicly available online at the SEC's website.

Use of a Form D is only a "safe harbor." This means that, if you can meet the Form's requirements, you are assured that you have a valid exemption from registration. One of the basic requirements is that you file your Form D within 15 days after the first stock sale in the offering you need the exemption for. So what happens if you intentionally choose not to file?

While the rules are not explicit, the SEC has stated that if you fail to file your Form D, you do not automatically lose your safe harbor and your exemption. Regardless, it is one thing to miss a deadline or mistakenly think someone else made the filing and quite another to intentionally choose not to file. For other sections of Reg. D, the SEC allows you to make insignificant deviations from the rules so long as you made a good faith and reasonable effort to comply. Willfully deciding not to file is not a "good faith reasonable effort" to comply with the rules. Also, the SEC has the power to ban you from using Reg. D in the future if you fail to file a Form D. If the SEC believes you are doing this willfully, it is likely to increase the chance that they will impose this ban.

In addition, without the safe harbor, you will have to rely on the general "4(2)" exemption from registration. 4(2) seems very broad -- it exempts any offering "not involving any public offering." Unfortunately, it is so broad that it is very hard to know exactly what it means. The SEC refuses to give clear guidance on how to apply the test. In fact, this is precisely one of the reasons Reg. D was created. Moreover, the courts that have looked at this issue have come out all over the map -- the US Supreme Court even ruled that an offering to one or two people could be a public offering. Consequently, it is often difficult for a lawyer to give his opinion that you made a successful 4(2) offering.

Whether or not you are getting a legal opinion, it is still very important that the company itself feel good that it has a valid 4(2) exemption. This can be exceptionally difficult, especially when there is a large number of investors or when any of these investors are inexperienced in investing or do not have that much money to invest. These are precisely the sorts of people that the courts try to protect -- and these are also precisely the sorts of people most start-ups rely on in their friends and family or seed rounds. If your company ends up not working out, these are the people that may seek protection from a court and in hindsight, the court may determine that your offering was not sufficiently private to meet the vague 4(2) standards. Further, it is your responsibility in the lawsuit to prove that you met the terms of this vague standard.

In addition, when looking at a 4(2) offering, the court will examine every single person that you made an offer to. This is different than a Reg. D offering where the rules only look at who actually purchased shares. If you made an offer to one illegal person, even if that person did not buy stock, you lose your exemption for everyone in the deal. Also, in a 4(2) offering, some courts require that you give the equivalent of an IPO prospectus to every person you offer shares to. It can be very difficult to prove that every person you made an offer to received sufficient information.

So, the next question is, what does it mean if I blow the 4(2) exemption and can't use Reg. D or some other exemption? The main penalty is called "rescission." This means that you have to give every investor the right to take his money back. In good times, this is not such a bad thing as most investors will want to leave their money in your company. However, in bad times, this can be a company killer. Further, it is usually when you are having bad times that your investors start bringing suits that claim you did not have a valid exemption for the offering. Even if your company is gone, the unhappy investor may be able to recover his investment directly from the old officers and directors. All of this is in addition to whatever fines and legal penalties the government may be able to bring against you.

In conclusion, choosing to stay in stealth mode while also raising capital can be a very tricky choice to make. Prior to the revisions to Form D, there may have been some justification for using a 4(2) exemption instead of Reg. D. However, now that the Form has been revised, in the majority of cases a company in stealth mode will now want to file their Form D and arrange it so that they make the minimum possible disclosures. Click Here to Read More..

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This blog reflects the personal views of Hank Heyming, in his individual capacity. It does not necessarily represent the views of his law firm or his clients, and is not sponsored or endorsed by them. No representation is made about the accuracy of the information contained hereon. By using this blog you understand that this information is not provided in the course of an attorney-client relationship and is not intended to constitute legal advice. This blog should not be used as a substitute for competent legal advice from a licensed attorney in your state. This blog is not intended to be advertising and Hank Heyming does not wish to represent anyone desiring representation based upon viewing this blog in a state where this blog fails to comply with all laws and ethical rules of that state.